Crypto investors are complaining about the same 'biggest pain point,' and fixing it could add billions to the bitcoin market

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Crypto markets are in dire need of middle-men to attract billions in mainstream institutional money, market experts tell Business Insider.
Specifically, prime broker services — which would allow investors to more easily trade across exchange venues — are seen as something that could lure in Wall Street to the nascent market.
A number of startups are starting to dip their toes into providing these types of services, but it's still early.

There is a dearth of middle-men in the crypto investing world, and it is causing a big headache for crypto investors and likely keeping out billions in mainstream institutional money.

On Wall Street, middle-men — called brokers — sit between institutional investors, like a hedge fund or money manager, and exchanges and other trading venues. Such operations are hard to come by in the crypto world because the barriers to entry are high.

As a result, if a crypto investor wants to trade coins they have to keep a balance on an exchange. Michael Moro, the head of over-the-counter trader Genesis Global Trading, says this translates into illiquidity and disparities in pricing which can eat into profits.

"The better option from a market structure perspective is to have a prime broker sitting in the middle where all you have to do is wire one account and you can trade across all of them simultaneously," Moro said.

A number of companies in crypto are looking at providing so-called prime services, meaning a broker would extend credit to its clients so that they can trade across exchanges without depositing funds themselves. The move comes as mainstream Wall Street firms like Goldman Sachs are starting to dip their toes into trading crypto products and are looking for market safeguards and infrastructure that they're accustomed to.

Crypto startup SFOX is interested in offering prime services in the future, people familiar with the matter tell Business Insider, and it is currently talking to outside lawyers about a potential offering. Digital Gamma, a crypto company, is also working on prime services, a spokesperson told Business Insider.

Coinbase, the crypto exchange, is looking to provide a number of broker-related services.

Mike Belshe, founder of BitGo, a crypto custody company, said his firm might one day enter the business, but it is currently more interested in perfecting its custody products.

The potential introduction of prime services into the crypto world is a bit ironic. Bitcoin, the largest digital currency on the market, was founded in the aftermath of the financial crisis as an alternative peer-to-peer financial system to Wall Street that would render middle-men useless.

Still, Colleen Sullivan, the head of crypto venture firm CMT Digital, said the lack of a prime broker is one of the biggest issues holding the crypto space back. Having to self-finance at each exchange opens the firm to more risk than what is the norm on Wall Street. She described the lack of prime services in crypto as CMT Digital's "biggest pain point."

"Without a prime broker, trading firms are directly subject to events that an exchange may suffer like hacks, regulatory issues, operational issues, technology issues (and many more) — all of which may lead to loss of the trading firm’s cash and coin," she said.

Prime brokers arose in the equities markets in the early 1990s, around the same time that the hedge fund industry started to take off.

According to banking research firm Coalition, the top 12 largest banks collectively brought in $4.9 billion from their prime broker units in the first quarter of 2018, the highest level in the last three years.

In crypto, there's also lucrative opportunity, says BitGo's Belshe. But Wall Street firms are less likely to get into the business than smaller crypto firms because at this point the market isn't large enough to justify the risk. The entire market for digital currencies stood at $235 billion, while the stock market worth $30 trillion in the US.

As for crypto firms, they have their own difficulties, said CMT Digital's Sullivan. To offer prime services, a firm would require a large balance sheet which many small startups don't have. It would also require a firm to connect to each exchange a client wants to trade on.

"Many exchanges in the US and overseas are largely unregulated," she said. "So the prime may not even be able to be counterparty to certain exchanges depending on what the regulatory regime the prime is subject to."

Kiran Nagaraj, KPMG's leader of cryptocurrency services, said that large institutional firms have been sitting on the sidelines to enter the crypto market because they have an expectation for white-glove service.

Aside from traditional prime-services, brokers need to support institutions on crypto-specific issues such as managing crypto forks — when a crypto splits into two — in order for them to enter the market in a serious way. Big investors, Nagaraj says, don't want to be concerned with the technicals.

"They're in the investment business," he said. "They can't hold their own private key. Maybe you'll find some that'll do it, but they are looking for market exposure. They don't want to deal with the operations."

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